Matakuliah
Tahun
: A0814/Investment Analysis
: 2009
TECHNOLOGY JUSTIFICATION MODELS
Pertemuan 15-16
Technology Justification Models
• Understanding the technology justification models can
make the difference between anecdotal support and
objective evidence of the business value of IT
investment
• The purpose of the justification models is to convert the
relationship between IT investment and anticipated
payoff into a logical or mathematical form, while
accounting for other factors that might affect the
measurement along the way.
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• The objective of a model is to isolate the surplus profits
that can be attributed to the investment.
• The complexity of models increases as other facotrs are
added on to either the cost or benefit side of the
equation.
• Justification models may be more appropriate given
various organizational imperative such as upgrading
existing technology, investing in IT infrastructure, and
acquiring new IT applications.
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Some of Justification Models
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Intuition-based models
Cost-benefits analyses
Break-even point
Net present value (NPV)
Economic value added (EVA)
Regression-based statistical models
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• The payoff justification is driven by a desire to satisfy an
internal realtions need rather than any real concern for IT
investment.
• “appearance” factors, focus groups consisting of a crosssection of client individuals can provide the public
relations exposure as well as useful feedback of what
they perceive as importan.
– Focus groups can help guide the IT payoff process toward
identifying the key variables that should be captured for costs as
well as benefits.
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• Logical or intuition-based models
– Represent the relationship between cost and benefit in a
mathematical or graphical format and are widely used to
examine the benefits from an investment as well as to determine
the time to recoup the investment.
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Cost Benefit Analysis
IT Payoff = [Savings (in hours) for all problem resolution x
Average hourly wage rate] – Cost of help desk
implementation
P=[∑(Hb – Ha) x W)] – [Ch + Cs + Ci]
Where :
P
Hb
Ha
W
Ch
Cs
Ci
= Payoff
= hours before implementation
= hours after implementation
= average wage rate
= hardware costs
= software costs
= laobr costs
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• The formula is a representation of a cost-benfit analysis
that can be as simple as summing the total
implementation costs from the general ledger and
aggregting the total intangible benefits.
• Additional savings from the help desk can be added by
accounting for quick troubleshooting, better customer
service due to fewer downtime occurences, and
improved customer satisfaction and retention.
• The cost-benefit approacth is a practical approach for
most situations, however, the dept of the analysis
depends upon the deman for IT justification and other
factors contributing to IT payoff.
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Break Evan Point (BEP)
• Is generally used to identify the point at which the
system investment has paid for itself
• BEP is the same as cost-benefit analysis, when the
cost=benefits or cost – benefits = 0
• The payback period determines the duration of time in
which the system is paying for itself. The duration of time
during which the BEP is reached.
• Whereas the BEP may be expressed in units of service
or parts, the payback period is expressed in units of time
such as the number of weeks, months, or years
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Net Present Value (NPV)
• Represent time value of money
• Discount Factor (DF) is the rate at which the company
would have accumulated more money if it had not
invested in the IT.
• This is based upon the interest rates and the returns
from the stock market. Calculating DF is usually the
more challenging part because it requires experience
and educated guesswork as to how the market will
behave in the future.
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• How can NPV help in measuring IT payoff?
– The investment in IT payoff competes with other investments
such as manufacturing equipment, additional distribution
centers, and advertising. Managers may examine the NPV value
of continued investment in IT agains that of other investments in
determining the expected payoff and then decide which
investment to make.
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The Real Options Approach
(a) Expected NPV Payoff
Year 2
Year 3
Year 4
(b) Pushing NPV using Real Options
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(c) Expected Payoff with Real Options
The Real Options Approach
(a) Indicates the NPV concept, shere the shaded area is
the most likely NPV. The right side area is the most
likely NPV. The curve represents the likelihood of the
value over the 4-year period of the investment.
the curve assumes that once the decision to invest is
made, it will continue to occur at the same pace for the
next 4 years. The right side area represents the
likelihood of the expected payoff.
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(b) at each year starting the second year, the management
can evaluate the IT investment payoff and set the future
direction, in effect pushing the curve so that the
opportunities are availed f and the risks mitigated
(c) Indicates the revised the right area using the Real
Options approach. As is evident, pushing the curve out
leads to an increased likelihood of achieving the
expected payoff.
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• The key contribution of the Real Options approach is its
ability to take advantage of unexpected or or unforeseen
opportunities.
• The real options approach would then be comparable to
a 30 year lease where one has the option to renew the
terms, sublease the property, and the lease in each year,
or buy the property.
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Economic Value Added (EVA)
• Is defined as the return on invested capital, that is, aftertax cash flow generated by a company, minus the cost of
the capital in creating the cash flow.
• For IT payoff, EVA can serve as a complementary tool,
when NPV and Real Options are being calculated by
accounting for the cost of capital to assess the value of
the investment.
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Statistical Approaches
• To assist in finding and understanding the relationship
between the investment and payoff.
– Examine the correlation table listing the strength of the
relationship between the investment (independent) variables,
and the payoff (dependent) variables.
– A perfect positive correlation is indicated by a coefficient of 1.0
and no correlation is indicated by a coefficient of 0.
• Since the correlation of 1.0 is a perfect relationship, this
indicates a strong relationship between IT investment
and payoff.
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• The regression equation will convey the extent to which
the variation in profit can be explained by workload,
number of orders, and expenditures on IT through the
reported statistic R-square.
• The significance of F value will suggest if our proposed
relationship is statistically valid.
• The coefficient and their corresponding p values will
show the extent to which each independent variable
contributes to determining profits and the confidence we
can plance in determination.
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